4/18/2009 @ 10:30AM

Buy-And-Hold In Disrepute

A nation of burned investors needs rose-colored glasses to believe the Obama and Bernanke “green shoots” public relations campaign means we’re headed for a new bull market.

Many ordinary investors, along with well-heeled ones, saw their holdings in U.S. equities lose 50% of their value from 2007 to 2008 and into earlier this year. They lost even more in Russia and other emerging markets–to the tune of 70% or more–if they bought into the “BRIC” investing concept promoted hard by
Goldman Sachs
in the early part of the decade.

BRIC stands for Brazil, Russia, India and China–the preferred markets for growth in the 21st century. They were not supposed to lose more value than U.S. stocks; BRIC nations were meant to grow faster. In reality, they turned out to be more volatile, less liquid and very dangerous. You needed to buy and sell, not buy and hold. If you bought and held, you had the pleasure of the run-up followed by the pain of the collapse.

The truth is that the public was badly served by its investment advisers, like Alliance Bernstein, or their big public mutual funds, which stayed 100% invested all through the lead-up to the worst financial crisis since the 1930s. They took little or no money off the table. They never called your Aunt Sadie to advise her to take profits in 2006 and 2007 before the bottom dropped out.

The professional advisers were good at getting you in but were daydreaming when they should have gotten the public out. Were you told to sell your
General Electric
or your
Citigroup
before they became single-digit stocks? Many value-oriented funds were buying
Fannie Mae
months before it became Uncle Sam’s property. Even Warren Buffett was loading up on banks stocks as they were about to disintegrate.

Folks, buy and hold is in disrepute.

Investors beware: You have to watch over your money like hawks, read your monthly statements and ask questions. You must be active, not passive, when dealing with commoditized investment firms that are rotten at knowing when to sell. Why should they know? They’re paid based on the amount of money you hold in their funds, and receive little compensation for keeping that cash safe.

Risk has been heretofore little understood, but it is the reason so many investors are firing their investment advisers and looking for someone more astute, more trustworthy and more focused on individualized investor needs.

Advisers are firing their firms, too, in a way. With the shake-up on Wall Street, firms are going out of business or merging, and advisers are moving from one firm to another or striking out on their own.

Sophistication, or at least the well-varnished appearance of such, was no shield from the market’s drubbing. Big money in the form of pension funds, educational endowments and wealthy estates rushed to emulate Yale University and put at least 20%–sometimes more–of their holdings in private equity, hedge funds, timber, real estate and venture capital. These holdings are illiquid–they can’t be sold quickly to raise money to pay expenses of universities like Harvard, Yale, Duke, Penn, University of Virginia or Notre Dame.

Do the arithmetic: Your endowment has 80% in common stocks, which just lost half their value. Your alternative investments are off 30% to 50% as well. The result: Your portfolio is only about half what you owned a year ago. Suddenly, your alma mater has to delay building projects, freeze salaries and raise money in the public markets to stay open. Today, your leveraged buyout loans are selling at 60 cents on the dollar, your hedge funds won’t let you liquidate your holdings and nobody wants to bid on your real estate.

The accepted wisdom of yesteryear–buy and hold, overweight Brazil, Russia, India and China and give your money to Blackstone, Apollo and KKR–aren’t working. It’s crisis for investors more than it is for their advisers, who are still getting fat fees.

Yes, we have had a nice rally. Some believe this to be more than a bear-market rally. They believe the lows in stock prices have been made. The Fed and the Treasury are trying to put a floor under mortgages and bank loans. China’s economic stimulus program has stabilized growth at 6%, still respectably solid. Citigroup,
JPMorgan Chase
and
Wells Fargo
are reporting profits. Hallelujah!

Let’s have a reality check. Sam Stovall, chief strategist at Standard & Poor’s Equity Research, says that based on past historic patterns, it could take another six years for the S&P 500 Index to retrace back to the 1,500 peak it hit in 2007. “Meanwhile, your equity will be growing in value,” he says.

The despair of the system’s breakdown may be over. The “plumbing” of the financial system has stabilized it, says the manager of a $12 billion hedge fund. No more U.S. financial firms are to become wards of the state. There’s another $1 trillion in the hopper for the insurance companies. No doubt there’s a further stimulus program to prime the pump of the economy.

Don’t put all you have in stock, warns this hedge fund manager. The recession is not over. Consumer spending will be rotten for some time. S&P’s Stovall sees U.S. gross domestic product declining 3.5% in 2009, and hopefully, he says, it might be growing at 1% to 2% in 2010.

To the degree that stock returns follow the economy–and if you add in a 3% dividend yield to that 1% to 2%–you get modest 4% to 5% gains in the overall market. Stovall sees earnings turning around by the end of 2009, and unemployment topping at 10% in early 2010.